Investing In Bitcoins

Should You Invest In Bitcoins?

Over the holidays, the digital currency Bitcoin attracted attention by fluctuating dramatically in value, increasing from $110 US in September to $1,100 in early December, then back down to $550 in mid-December. The currency, formerly best-known for being the trading chips in online black market the Silk Road, is making its foray into the mainstream, and has many wondering whether or not to invest.

Some have already taken the leap of faith: The Peter Thiel Foundation has invested $3 million and the Winklevoss twins made a personal investment of $1.5 million. The IRS is already studying how bitcoins may be taxed.

However, many economists have decried the currency due to its volatility. The roller coaster of activity over the past few months is a prime example. The value shot up dramatically after it was declared in a United States Senate committee hearing in November that "virtual currencies were considered a legitimate financial service." However, in early December, China prohibited Chinese financial institutions from using bitcoins, and the value of the currency quickly dropped by 40%.

Regardless of whether or not the currency will be recognized as legitimate by major national financial institutions, it is still recognized, even by China, as a "commodity" — and this means merchants can choose whether or not to accept it in exchange for goods and services. According to Wikipedia, there are currently 1,000 physical merchants and 20,000 online merchants that accept bitcoin as payment — some of which include OkCupid, WordPress and Virgin Galactic.

There are already several Bitcoin ATMS at which you can exchange cash for bitcoins across the world. The first opened in Vancouver in late October and was followed by others in Hong Kong, Slovakia, San Diego, Helsinki, and most recently Toronto.

Bitcoins prove particularly useful in transferring money across nations, as there is no exchange rate and there are no transaction fees. The bitcoin ATMs do no even require you to have a bank account or verify your identity. However, these are the types of details that have some governments concerned about bitcoins aiding illicit activities.

So how are bitcoins produced? The process is called "mining," and it involves a network of "miners" maintaining large CPUs that solve irreversible cryptographic puzzles which unlock "blocks" of bitcoins. A recent Wired article explained that the difficulty of the puzzles increases as the number of miners increases, which slows production to roughly one new block every 10 minutes. Every 210,000 blocks, the size of each block is cut in half. Back in 2009, when bitcoins were first being mined, a block consisted of 50 bitcoins and has since decreased to 25, then 12.5, and so on since. There is a finite number of bitcoins — 21 million — and no more will be created after the mining of all units is complete. The creator of bitcoin, a mysterious figure known as Satoshi Nakamoto whose virtual presence disappeared in December of 2010, designed the process to avoid inflation of the currency. The process of mining is the rebuttal to those who criticize the ambiguity of bitcoin use value, as the labor value is clearly established.

A New York Times article published over the holidays touched on the some of the environmental concerns regarding the CPUs that mine bitcoins. The CPUs used in Iceland that do the bulk of bitcoin mining are worth $20,000 each and use large amounts of energy that cause them to overheat, requiring a cooling mechanism. Not only has this led some to believe bitcoin mining to be wasteful, but money spent on energy costs and machine depreciation affects the profitability of the mining as well.

At this point, the methods of obtaining bitcoins are: exchanging cash; mining; and selling products and services for bitcoins. An article published on TechCrunch last April briefly describes how to get into "pooled mining" of bitcoins, meaning you hook up with a group of people to split the work. It sounds intriguing for the technically inclined, but for the average Joe, you may be biting off more than you can chew.

We have yet to see how the legacy of bitcoins will unfold. Some have compared the phenomenon to the "Tulip Mania" of the early 1600s. If you invested back in the early days, it should be a wild ride, but for the rest of us, it may be best to just sit back and watch.